Investments, tenth edition

 Example  20.7 

Indexed-Linked CDs 

 The index-linked CD has several variants. Investors can purchase similar CDs that guar-

antee a positive minimum return if they are willing to settle for a smaller multiplier. In this 

case, the option is “purchased” by the depositor for ( r  

 f 

   2   r  

min

 )/(1  1   r  

 f  

 ) dollars per dol-

lar invested, where  r  

min

  is the guaranteed minimum return. Because the purchase price is 

lower, fewer options can be purchased, which results in a lower multiplier. Another variant 

of the “bullish” CD we have described is the  bear CD,  which pays depositors a fraction of 

any  fall  in the market index. For example, a bear CD might offer a rate of return of .6 times 

any percentage decline in the S&P 500.    

bod61671_ch20_678-721.indd   708

bod61671_ch20_678-721.indd   708

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  C H A P T E R  

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  Options Markets: Introduction 

709

 Continue to assume that  r  

 f 

   5  3% per half-year, that at-the-money calls sell for $50, and that the market 

index is at 1,000. What would be the multiplier for 6-month bullish equity-linked CDs offering a guaran-

teed minimum return of .5% over the term of the CD? 

 CONCEPT CHECK 

20.9 

  Options markets have been tremendously successful. Investors clearly value the portfolio 

strategies made possible by trading options; this is reflected in the heavy trading volume 

in these markets. Success breeds imitation, and in recent years we have witnessed con-

siderable innovation in the range of option instruments available to investors. Part of this 

innovation has occurred in the market for customized options, which now trade in active 

over-the-counter markets. Many of these options have terms that would have been highly 

unusual even a few years ago; they are therefore called  exotic options.  In this section we 

survey a few of the more interesting variants of these new instruments.